For investors owning agency-backed CMOs, which risk is LEAST important during rising interest rates?

Payment risk is considered the least important risk for investors owning agency-backed Collateralized Mortgage Obligations (CMOs) during periods of rising interest rates.

Agency-backed CMOs are typically backed by government-sponsored entities, which reduces concerns regarding borrower defaults and payment issues. As a result, the likelihood of homeowners failing to make mortgage payments, thereby affecting the cash flows to investors, is lower compared to other types of securities. In a rising interest rate environment, while other risks such as interest rate risk become more pronounced—because changes in rates can influence the price volatility and attractiveness of existing bonds—payment risk remains relatively stable due to the backing of reliable agencies.

In contrast, liquidity risk, interest rate risk, and credit risk gain importance during periods of rising interest rates. Liquidity risk can increase as investors may seek to sell their holdings to cope with changes in interest rates. Interest rate risk directly impacts bond prices and can significantly affect valuations. Credit risk, although mitigated by agency backing, can still be a concern if broader economic conditions change unexpectedly.

Ultimately, investors in agency-backed CMOs can be more at ease with payment risk since the agencies provide a strong layer of protection against default, making it less of a pressing concern in the context of rising